Two companies, Energen and Hastings Corporation began operations with identical

Question

Two companies, Energen and Hastings Corporation began operations with identical balance sheets. 1 year later both required additional fixed assets costing $50,000. Energen obtained a 5 year $50,000 loan at 8% interest from the bank. Hastings decided to lease the $50,000 capacity for 5 years and an 8% return was built into the lease. The balance sheet for each company, before the asset increases follows:
Current Assets $25,000 Debt $50,000
Fixed assets 125,000 Equity 100,000
Total assets $150,000 Total Claims $150,000

Show the balance sheet after the asset increases, and calculate each firm’s new debt ratio (assume the lease is not capitalized). Also show how Hasting’s balance sheet would look immediately after the financing of the capitalized lease.

Explanation / Answer

a.Balance sheets before lease capitalized

Energen Balance-sheet
Current Assets-           $25,000                   Debt-                 $100,000
Fixed Assets-             $175,000                    ($50,000 + $50,000) ($125,000 + $50,000)                     Equity-                         $100,000
Total Assets              $200,000                    Total claims           $200,000

Debt Ratio = Debt/Total assets
= $100,000/$200,000 = 50% Hasting Corporation Balance-sheet  
Current Asse         $25,000                               Debt                         $50,000
Fixed Assets         $125,000                              Equity                      $100,000  
Total Assets        $150,000                               Total claims            $150,000
Debt Ratio=Debt/total assets =$50,000/$150,000 = 33% b. Hasting Corporation Balance-sheet after Lease capitalization
Hasting Corporation Balance-sheet  
Current Assets         $25,000                               Debt                          $50,000
Fixed Assets           $125,000                              PV of lease Payment $50,000
Leased Assets         $50,000                               Equity                      $100,000
Total Assets           $200,000                               Total claims             $200,000

Debt Ratio = Debt/Total assets
= $50,000/$200,000 = 50%

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